Saturday, October 08, 2011

The cost of growth

This market is ugly. Who would have thought that 3 years after the market meltdown of 2008 we are still suffering from the repercussions?

I am still waiting for the general stock market to start moving upwards in the way that all pension advisers claim that it does. In the meantime those who want a return on their investments are going to have to do more than invest in an index tracker.

My flight to quality is paying off big time. While most industrial stocks have tanked and banks remain in the doldrums some technology stocks have actually grown. Look at the chart below:

This is the 5 year chart for IBM. Here is something that you won't find in many places. Growth in the last 5 years!

The surprising thing is that companies like this are not hard to find. Here are five the come to mind instantly: Apple, Google, Microsoft, Intel, Intuitive Surgical.

What are the key qualities that separate these companies from the industrials that Warren Buffet understands and loves?

1. Large amounts of intellectual property.

These companies don't make commodities. They produce something that is hard to compete with. Banks may all copy each other's products but could you copy one of Intel's processors?

2. Cash rich with little or no debt.

These companies throw off cash in the normal course of operations. Some of them have so much cash that the idea of needing to borrow money is laughable.

3. Low cost of growth.

Producing new products for the companies above is just an ongoing process, not an extra cost. If BHP Billiton wants to grow it has to carefully weigh up the cost of building a new mine against the potential reward. The above companies have engineers that design new technology every day. Some of them have no direct competition (Intuitive Surgical.)

4. High margins.

When your product is unique you can charge a lot for it. Google can charge a lot for its marketing services as no other internet company has its reach. Apple can charge a fair price for its iPad as no other product comes close to it.

Sometimes investors are guilty of thinking too much about what they do. This results in confusion and much thrashing about. It probably explains why I ended up with large chunks of my portfolios in banks, miners and even airlines.

As a personal investor you have huge advantages over funds. You can invest in anything, there are no portfolio weighting restrictions and you do not have to show results within any particular time frame. How many of us throw away these advantages by applying restrictions to our portfolio and over diversifying?

My understanding of investing is maturing. I have still not managed to offload industrials such as BP and BHP Billiton. I still have bank holdings. It is hard to sell securities that currently look so cheap. And there will come a day when these companies will outperform the market. But long term I am going to concentrate on beauties and leave the ordinary for the funds.